monopoly etp economics 101. monopoly a firm is considered a monopoly if... it is the sole seller...

Monopoly

ETP Economics 101

Monopoly

A firm is considered a monopoly if . . . it is the sole seller of its product. its product does not have close substitutes.

The fundamental cause of monopoly is barriers to entry.

Sources of Barriers

Barriers to entry have three sources: Ownership of a key resource. The government gives a single firm the

exclusive right to produce some good. Costs of production make a single producer

more efficient than a large number of producers.

Sources of Barriers- continued

Although exclusive ownership of a key resource is a potential source of monopoly, in practice monopolies rarely arise for this reason.

Governments may restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets.

Patent and copyright laws are two important examples of how government creates a monopoly to serve the public interest.

Natural monopoly

An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms.

A natural monopoly arises when there are economies of scale over the relevant range of output.

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Quantity of Output

Averagetotalcost

0

Cost

Monopoly vs Competition

Monopoly versus Competition Monopoly

Is the sole producerFaces a downward-sloping demand curve Is a price makerReduces price to increase sales

Competitive Firm Is one of many producersFaces a horizontal demand curve Is a price takerSells as much or as little at same price

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Quantity of Output

Demand

(a) A Competitive Firm’s Demand Curve (b) A Monopolist’s Demand Curve

0

Price

Quantity of Output0

Price

Demand

Monopoly’s Revenue

Total Revenue

P Q = TR Average Revenue

TR/Q = AR = P Marginal Revenue

TR/Q = MR

Numerical Example

Monopoly’s MR and Price

A Monopoly’s Marginal Revenue A monopolist’s marginal revenue is always less

than the price of its good.The demand curve is downward sloping.When a monopoly drops the price to sell one more

unit, the revenue received from previously sold units also decreases.

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Quantity of Water

Price

$1110

9876543210

–1–2–3–4

Demand(averagerevenue)

Marginalrevenue

1 2 3 4 5 6 7 8

Profit Maximization

A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost.

It then uses the demand curve to find the price that will induce consumers to buy that quantity.

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QuantityQ Q0

Costs andRevenue

Demand

Average total cost

Marginal revenue

Marginalcost

Monopolyprice

QMAX

B

1. The intersection of themarginal-revenue curveand the marginal-costcurve determines theprofit-maximizingquantity . . .

A

2. . . . and then the demandcurve shows the priceconsistent with this quantity.

Profit Maximization Conditions

Comparing Monopoly and Competition For a competitive firm, price equals marginal

cost.

P = MR = MC For a monopoly firm, price exceeds marginal

cost.

P > MR = MC

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Monopolyprofit

Averagetotalcost

Quantity

Monopolyprice

QMAX0

Costs andRevenue

Demand

Marginal cost

Marginal revenue

Average total cost

B

C

E

D

Case: Market for Drug

With Patent Patent is expired

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Quantity0

Costs andRevenue

DemandMarginalrevenue

Priceduring

patent life

Monopolyquantity

Price afterpatent

expires

Marginalcost

Competitivequantity

Welfare Cost of Monopoly

In contrast to a competitive firm, the monopoly charges a price above the marginal cost.

From the standpoint of consumers, this high price makes monopoly undesirable.

However, from the standpoint of the owners of the firm, the high price makes monopoly very desirable.

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Quantity0

Price

Demand(value to buyers)

Marginal cost

Value to buyersis greater thancost to seller.

Value to buyersis less thancost to seller.

Costto

monopolist

Costto

monopolist

Valueto

buyers

Valueto

buyers

Efficientquantity

Deadweight Loss

Because a monopoly sets its price above marginal cost, it places a wedge between the consumer’s willingness to pay and the producer’s cost. This wedge causes the quantity sold to fall short

of the social optimum. The Inefficiency of Monopoly

The monopolist produces less than the socially efficient quantity of output.

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Quantity0

Price

Deadweightloss

DemandMarginalrevenue

Marginal cost

Efficientquantity

Monopolyprice

Monopolyquantity

Public Policies Toward Monopoly

Government responds to the problem of monopoly in one of four ways. Making monopolized industries more

competitive. Regulating the behavior of monopolies. Turning some private monopolies into public

enterprises. Doing nothing at all.

Antitrust Laws

Antitrust laws are a collection of statutes aimed at curbing monopoly power.

Antitrust laws give government various ways to promote competition. They allow government to prevent mergers. They allow government to break up companies. They prevent companies from performing activities that

make markets less competitive.

Regulation on Prices

Government may regulate the prices that the monopoly charges. The allocation of resources will be efficient if

price is set to equal marginal cost.

Loss

Quantity0

Price

Demand

Average total cost

Regulatedprice Marginal cost

Average totalcost

Public Ownership

Rather than regulating a natural monopoly that is run by a private firm, the government can run the monopoly itself (e.g. in the United States, the government runs the Postal Service).

Do Nothing

Government can do nothing at all if the market failure is deemed small compared to the imperfections of public policies.

Price Discrimination

Price discrimination is the business practice of selling the same good at different prices to different customers, even though the costs for producing for the two customers are the same.

Price discrimination is not possible when a good is sold in a competitive market since there are many firms all selling at the market price. In order to price discriminate, the firm must have some market power.

Perfect Price Discrimination

Perfect Price Discrimination Perfect price discrimination refers to the

situation when the monopolist knows exactly the willingness to pay of each customer and can charge each customer a different price.

Effects of Price Discrimination

Two important effects of price discrimination: It can increase the monopolist’s profits. It can reduce deadweight loss.

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Profit

(a) Monopolist with Single Price

Price

0 Quantity

Deadweightloss

DemandMarginalrevenue

Consumersurplus

Quantity sold

Monopolyprice

Marginal cost

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Profit

(b) Monopolist with Perfect Price Discrimination

Price

0 Quantity

Demand

Marginal cost

Quantity sold

Examples

Examples of Price Discrimination Movie tickets Airline prices Discount coupons Financial aid Quantity discounts